May 2024 Monthly

[PocketOption]

May 2024 Monthly

The resilience of the
US economy and stickiness of price pressures spurred a reassessment of the
trajectory of Fed policy. This sparked a sharp rise in US interest rates and
extended the dollar's advance. The somewhat disappointing April jobs report and
a softer CPI report in the middle of May could signal that the interest rate
adjustment is over. Federal Reserve Chair Powell played down the likelihood of
the need to lift rates again, and as it was in  Q4 23, when CPI moderated to a 2%
annualized rate, the central bank is being prudent in both directions. 

The IMF identified US fiscal policy
as a key to fueling demand, inflation, and the stronger greenback, which has
heightened concern among several countries in the Asia Pacific region,
including Japan, South Korea, China, and Indonesia. It appears that Japan
intervened materially in late April and again in early May. Indonesia hiked
rates to defend the rupiah. South Korea, and a few other countries in East Asia
expressed concern about the pressure on their currencies. 

Europe is not providing anywhere close to the US fiscal support.
As a consequence, the EU and UK are nearly stagnant, and the repair of supply
chains have seen inflation trend lower. That said, both the EU and UK economies
appear to have found better footing here in early 2024 after contracting late
last year. Still, the combination of weak growth impulses and falling
price pressures will likely allow the European Central Bank, the Bank of
England, and Sweden's Riksbank to begin cutting interest rates well before the
United States. Indeed, there is a reasonably good chance that the Riksbank
becomes the second G10 to cut rates, after the Swiss National Bank's move in
March. The movement of interest rate differentials and the dollar's
appreciation reflects the market's recognition of the growing divergence.

At the end of last year, it has looked like US inflation was
moderating quickly and economy has looked poised to slow considerably.
Throughout the most aggressive Fed tightening cycle in a generation, the market
had periodically discounted a more dovish policy only to subsequently
re-converge with the Federal Reserve. In December 2023, the median Fed forecast
was for three cuts in 2024, and the market the Fed funds futures had implied
more than six cuts would be delivered.

The continued employment gains and wage growth faster than
inflation, coupled with expanding consumer credit, helped fuel strong US
consumption. Price pressures proved stubborn, primarily as shelter costs have
not moderated as many economists, both on Wall Street and at the Federal
Reserve expected. Without shelter prices falling, it is difficult to be
confident that inflation is on a sustainable path back to 2% target. By the
March FOMC meeting, the additional confidence that Fed officials sought had not
materialized and March's data, delivered in April, shattered any remaining
confidence in the narrative of a "bumpy path" toward the target. The debate in
the market had transformed from hard landing vs. soft-landing to discussions of
re-accelerating growth.

The market has pushed out the timing of the Fed's first cut and
has reduced the extent of interest rate cuts this year, the derivatives market
is pricing in one quarter-point cut and about a 50% chance of a second cut.
Given the still strong job growth in April and the risk of continued sticky
inflation, the interest rate adjustment may continue. There may be scope for
the two-year note yield to climb toward 5.25% (from slightly below 5%), and
possibly more, in the coming weeks. The rate adjustment has sparked a sharp
setback in equities, after a dramatic rally in the first quarter. This, coupled
with geopolitical tensions, has fostered a risk-off environment, which is also
supportive of the dollar.

The Bank of Japan's rate hike in March failed to stem the yen's
sell-off. The yen appears to be more sensitive to US interest rates than
Japanese. Moreover, even with the rate hike, Japan is still the low yielder,
making in an attractive funding currency. Intensified verbal intervention
seemed largely shrugged off and the dollar broke above the JPY152 area which
had capped it in 2022 and 2023 on April 10 and took out JPY155 about two weeks
later.

Japanese official verbal intervention intensified, but with the
third consecutive US CPI above expectations, the dollar surged to almost
JPY160.20 in late April. The Bank of Japan appears to have sold around $58 bln
over two separate operations at the end of April and early May. Officially
confirmation is unlikely until the end of May. Still, if there was the
intervention, there are two notable features. First, officials intervened in
thin markets. This allowed their size to overwhelm the market. Second, it
appears Japan acted on its own. And even if Japan did not coordinate
intervention with others, no other central bank appears to have intervened at
the same time.

The weakness of the euro is unlikely to stand in the way of the
European Central Bank delivering a June rate cut. The ECB explains that it does
not target the exchange rate, but it is considered when in the forecasts growth
and inflation. Although several high-frequency economic series suggest that the
eurozone economy is off to a firmer start to the year, growth impulses still
seem muted. And while, unemployment in the region remains near cyclical lows,
despite the economic stagnation and rate hikes, the June European parliament
election may see voters express their frustrations.

Using formal and informal mechanisms, Chinese officials have
resisted the pressure on the yuan. As a low-yielder, and with low volatility,
the offshore yuan, like the Japanese yen, is a popular funding currency. If
Chinese officials were to step back and market forces were allowed a freer
hand, the yuan's decline would accelerate. Despite China's mercantilist
policies, it does not appear to be using the exchange rate to boost exports.
The offshore yuan surged on the back of the yen's (likely intervention-induced)
rally, and broader dollar pullback. Assuming it is reflected in the onshore
yuan, it may help to create more space for monetary policy.

The weight on the yuan cannot be dismissed simply because China
runs a trade surplus or that it has plenty of reserves to mount a serious
defense. The key factor is not the market for goods but for capital. The bond
market is not attractive, and investors do not have confidence in Chinese
stocks. The PBOC's continued gold purchases capture the imagination of many
observers and journalists, but Chinese investors themselves also appear to be
keen gold buyers as they seek alternatives to the property market and local
equities under the capital control regime.

Although the Chinese economy appeared to expand by more than
expected in Q1, the March data disappointed. It underscored the need for more
stimulus if the 5% annual growth target is to be achieved. Meanwhile,
China's industry subsidies irk its trading partners from the US and Europe to
some emerging market countries like Brazil. On her recent trip to China, Yellen
warned that China will encounter resistance to it efforts to export the product
of its excess capacity. Electric vehicles, batteries, and solar panels are the
source of the current angst. 

The US political cycle seemed to explain the Biden
administration's increase in tariffs on Chinese steel, which account for less
than 2% of US steel consumption. Around the same time that Biden called for the
increase in tariffs, he also reiterated his opposition to Nippon Steel's bid
for US Steel, ostensibly trying to bolster support in a key state for his
re-election, Pennsylvania. Including Japan in his broad accusation of
xenophobia, Biden seemed a bit exaggerated, or at least dated, as the number of
foreign residents in Japan increased by around 10% last year to 3.4 mln.
Japan's shrinking population is encouraging it to open in a significant way.

 
With the reassessment of the Federal Reserve's trajectory,
emerging market currencies struggled. The JP Morgan Emerging Market Currency
Index fell by about 0.75%. It was the fourth consecutive monthly decline and
left it 4.2% lower on the year. The MSCI Emerging Market Currency Index eased
by 0.55% and it is off about 2.5% below where it finished 2023. However,
emerging market equities outperformed the high-income equity markets. The MSCI
Emerging Markets Index rose by 0.25%, its third consecutive monthly advance.
Through April, it is up a little more than 2% this year. The MSCI World Index
of developed market equities fell nearly 3.9% in April, its biggest loss since
last September. Still, it has risen by about 4.25% in the first four months of
the year. The JP Morgan emerging market bond premium over Treasuries widened to
about 300 bp from 287 bp at the end of March. It had finished 2023 near 319 bp. 

The US dollar's broad strength was reflected in Bannockburn's
World Currency Index, which fell to new multi-year lows at the end of April.
Its 1.1% decline was the fourth consecutive monthly loss and the largest in
seven-month. The BWCI is a GDP-weighted basket of the currencies from the dozen
largest economies, split evenly between high-income countries and emerging
market economies. BWCI fell to new multiyear lows in early May and proceeded to
recover (from 91.70 to 92.20) and looks poised to return to the April high near
93.00, and possibly the March high closer to 93.50. This is consistent with the
consolidative phase for we anticipate for the dollar, which after a four-month
rally, means a weaker dollar bias.

In April, the dollar rose against all the other members of BWCI
but the Indian rupee, which was practically flat. After it, the Chinese yuan
was the next best performer, losing about 0.25%. The Australian dollar was the
strongest among the currencies of high-income countries, and it fell by about
0.75%. All the other currencies lost at least 1% against the dollar. The
Japanese yen saw the biggest decline in April, falling by slightly more than
4%. Since the intervention it is risen by about 3.2%. While the yen's losses
seem outsized, the Mexican peso and Brazilian real fell by a little less than
3.5% in April. Helped by an upgrade in Moody's outlook, which in part reflected
progress on fiscal reforms, the Brazilian real rose by about 2.4% in early May.
The peso rose a more modest 1%.

U.S. Dollar:  The real
broad trade-weighted dollar index rose 1.2% in April. It was the largest rise
since last October. The greenback rose against all the G10 currencies. The
gains were driven by a reconsideration of the trajectory of Fed policy in
response to continued elevated inflation readings and robust demand. By the end
of April, the market had pushed out the first cut to December. Recall that in
December, seeing 2% annualized CPI, the Fed expressed growing confidence that
inflation was on a sustainable path back to its target. The median Fed forecast
was for three cuts in 2024. The market, which often exaggerates in both
directions, had more than six cuts discounted in early January. At the end of
April, the futures market had 28 bp of easing this year and is around 45 bp
after the softer than expected April jobs report. The US economy appears to
have lost some momentum at the start of Q2, and we expect this will also
translate to a softer CPI and retail sales report (consumption) due in mid-May.
This could fuel an extension of the Dollar Index's pullback seen in the second
half of April. It settled near 105 after the jobs report. A break of the 104.25
area could target 102.80-103.00.

 
Euro:  After contracting in
the second half of 2023, the eurozone economy has begun to recover. The economy
expanded by 0.3% in Q1 24, which is the strongest growth since Q3 22. However,
the manufacturing sector remains challenged, and recovery seems fragile. The
progress on inflation appears to be stalling. The headline rate has fallen from
8.5% in the beginning of last year to 2.4% in March. It remained there in
April, and the base effect warns a higher reading over the next few months.
However, the core rate has continued to fall, and this appears helping to boost
confidence that the European Central Bank can deliver its first rate cut at its
next meeting on June 6, which also marks the beginning of the European
Parliament elections that run through June 9. At the end of last year, the
derivatives market had 190 bp of cuts discounted for this year. It has been
scaled back to about 60 bp, which is two cuts and about a 40% chance of a
third. The divergence between the expected trajectory of the Federal Reserve
and European Central Bank has weighed on the euro. The single currency fell to
$1.06 in mid-April, a six-month low but recovered to poke above $1.08 after the
US jobs data. A close above the March and April downtrend ($1.0810, falling to
around $1.0725 at the end of May). The initial target is in the $1.0870-$1.0900
area and then $1.0935-50

.
(As of May 3, indicative closing prices, previous in parentheses)
Spot: $1.0760 ($1.0790) Median Bloomberg One-month
forecast: $1.0830 ($1.0725) One-month forward: $1.0800 ($1.0775)   One-month
implied vol: 5.5% (5.0%) 

 
Japanese Yen: The Bank of
Japan hiked rates in March, but it did not do much for the Japanese yen. The US
10-year yield rose almost 50 bp in April, ostensibly offsetting in full the BOJ
rate hike. Pressure mounted on the exchange rate. The dollar was already
trading above JPY155 when the BOJ met in late April. Governor Ueda sounded
somewhat dovish and the BOJ's core inflation forecast for this fiscal year and
next remained at 1.9%. Ueda seems to show little direct concern about the yen's
weakness. The market responded quickly and before the day was out took the
greenback north of JPY158. Follow-though buying after the weekend (to almost
JPY160.20) appears to have trigged the first material intervention since 2022.
The market appeared to challenge Japanese officials and the BOJ appears to have
intervened again a few hours after the FOMC meeting concluded, when the dollar
was near JPY157.50. We think that what made the 2022 intervention
successful was that it coincided with a near-term top in US Treasury yields.
The 10-year US Treasury yield peaked in late October 2022 near 4.35% and fell
over the next six months by 100 bp. The 10-year US yield peaked on April 25
near 4.75% and traded to 4.45% after the US jobs data and the dollar briefly
traded below JPY152. Japan's Q1 GDP is due May 16. The economy likely
contracted by 0.3%-0.4% quarter-over-quarter, with consumption, investment and
net exports providing headwinds. Tokyo's April CPI fell more than expected
(1.6% core rate from 2.4%) and this signal a pullback in the national core
figures from 2.6% in March to, possibly, below 2%. We anticipate a
consolidative phase (JPY151-JPY156?)
 
Spot: JPY153.00 (JPY151.35) Median
Bloomberg One-month forecast: JPY152.45 (JPY149.15) One-month
forward: JPY152.30 (JPY150.75) One-month implied vol: 9.5% (7.7%) 

  

  

British Pound:  Sterling fell for the fourth consecutive month
in April, and its nearly 1% loss was more than the cumulative decline of the
previous three months. Still, it was the second best performing G10 currency
last month behind the Australian dollar. That speaks to the dollar's broad
strength more than an idiosyncratic challenge problem with sterling. Sterling's
decline came despite the rise in UK rates and a reassessment of the trajectory
of Bank of England policy. At the end of March, the swaps market was pricing in
almost 75 bp in cut this year. That has been reduced to almost 50 bp. The
market is wavering on the timing of the first rat cut between August and
September. There is slightly less than a 50% chance of June cut in the swaps
market. The Bank of England meets on May 9 and Q1 GDP is due the following day.
The market expects the economy expanded by 0.2% after a 0.3% contraction in Q4
23. The UK economy is not contracting as it was in H2 23, but growth is meager:
the labor market is slowing, and over the four months through March, retail
sales, excluding gasoline, were virtually flat in volume terms. The exchange
rate will likely be sensitive to the employment and wage data on May 14 and CPI
on May 22. Sterling recorded the low for the year on April 22 near $1.23. It
reached its highest level since the March US CPI on April 9 after the US jobs
report ($1.2635). The heavier US dollar we envisage could see sterling rise
into the $1.2700-50 area. 

  
Spot: $1.2545 ($1.2625) Median
Bloomberg One-month forecast: $1.2520 ($1.2650) One-month
forward:  $1.2550 ($1.2630) One-month implied vol: 6.3% (5.6%) 

 
Canadian Dollar:  The
Canadian dollar was no match for the greenback in April. It fell by about 1.5%
last month, its largest decline in six months. It was also the first losing
month in six for the S&P 500, illustrating the sensitivity of the Canadian
dollar's exchange rate to the broader risk environment. The swaps market has
downgraded the extent of Bank of Canada easing this year from about 75 bp at
the end of March to about 50 bp at the end of April. After some soft data in
early May, the market discounted nearly 65 bp of easing. The US two-year
premium rose to almost 80 bp last month, the highest since early 2019 and
pulled back to about 65 bp in early May. Still, the most important driver
continues to be the broad direction of the US dollar. The 60-day rolling
correlation of changes in the bilateral exchange rate and the Dollar Index is
near 0.85, its highest in over a decade. At the April meeting, the Bank of
Canada lifted this year growth forecast to 1.5% from 0.8%, encouraged by
stronger than expected exports and strong immigration, which officials think
may have boosted growth potential about 0.25% to 2.5%. Canada's first new major
pipeline in a couple of decades (Trans Mountain pipeline) will become
operational in early May. It will carry an additional 600k barrels of oil a day
from Alberta to the Pacific coast for exporting to Asia. Bank of Canada
Governor Macklem suggested that a June rate cut was possible, and the market is
pricing in a 2/3 chances. It may require a few closes below CAD1.36 for the
market to become more convinced a US dollar high is in place. The April high,
near CAD1.3850 was the highest since last November.

Spot: CAD1.3685 (CAD
1.3540) Median Bloomberg One-month forecast: CAD1.3635 (CAD1.3490) One-month
forward: CAD1.3680 (CAD1.3435) One-month implied vol:
4.9% (4.6%) 

 
Australian Dollar:  The
market has nearly given up on rate cut by the Reserve Bank of Australia this
year. Recall that as recently as early February, the futures market was
discounting two quarter-point cuts and a nearly 70% of a third cut. Now the
futures market points to an ever so slightly higher rate at the end of the
year, which seems to be an exaggeration. The macroeconomic data have been
mixed. Inflation slowed in Q1, though not as much as expected, and although,
full-time employment rose by 126k, offset a little more than the losses last
December, and the unemployment rate ticked up to 3.8%. The RBA meets on May 7
and the lack of urgency to cut rates will likely be expressed. The April jobs
report is a week later. Separately, the rally in the metals like iron ore,
copper, and gold may have helped lift sentiment toward the Australian dollar,
which was the best performing currency among the G10 in April, but it still
lost about 0.40% in April against the US dollar. After the US employment data,
the Australian dollar traded to almost $0.6650. It has traded above there once
since mid-January. A move above $0.6670 could signal a recover toward
$0.6750-$0.6800.

Spot: $0.6610 ($0.6520) Median Bloomberg
One-month forecast: $0.6605 ($0.6580) One-month forward:
$0.6615 ($0.6525)    One-month implied vol: 8.5% (7.5%)

 

Mexican Peso:  The dollar fell to nine-year lows near MXN16.26 in
the first part of April. A bout of profit-taking amid broadly stronger
greenback as the trajectory of Fed policy was reassessed. It has recovered to
nearly MXN17.17 through April 18 before surging above MXN18.21 on what is
dubbed a "flash crash" on news of Israel's retaliatory strike on
Iran. It subsequently traded to almost MXN16.90 before choppy consolidation.
The shock, reflected in a jump in volatility, has shaken the market's
confidence. The underlying fundamental considerations, such as the near-shoring
meme, attractive carry, solid external balances continue to hold. Improvement
in headline inflation appears to be stalling and the moderation in core prices
is slowing. The central bank meets on May 9, and it is likely to standpat after
cutting its overnight rate by 25 bp to 11.00% in March. With the June 2
election looming, and political violence elevated, many participants
may not be in a hurry to re-establish positions squeezed out of in the flash
crash. Although the peso has fully recouped its flash crash losses, market
sentiment seems more fragile than previously. 

Spot: MXN16.9750 (MXN16.56) Median Bloomberg One-Month
forecast: MXN17.0450 (MXN16.74) One-month forward:
MXN17.05 (MXN16.63) One-month implied vol: 10.4% (7.4%)

 
Chinese Yuan: China's
trade policies continue to be broadly criticized, but it does not appear that
officials are seeking export advantage through the exchange rate. The PBOC
continues to resist pressure on the yuan to depreciate. The yuan slipped less
than a quarter-of-one percent in April, and its year-to-date decline of around
1.8% is among the least in the emerging market world. China's stocks and bonds
also fared well. The 10-year government bond yield fell to record lows near
2.22% in late April before recovering to almost 2.40%. At the low, the yield
was less than half rate on the US 10-year Treasury. The mainland's CSI 300
rallied about 2.5% in April. It was the third consecutive monthly advance.
However, mainland shares that trade in Hong Kong surged by more than 8%. It was
nearly flat for the year at the end of Q1 24. We had thought there was
potential for the dollar to return to its previous range of roughly
CNY7.25-CNY7.30, but the greenback peaked slightly shy of the lower end of the
range. There is speculation in some quarters that Beijing is planning of a
large depreciation of the yuan. We are skeptical as officials have been
emphasizing the desire for exchange rate stability. The offshore yuan has been
allowed to trade beyond the onshore band, but it recovered smartly in early May
(while mainland markets were closed for the labor holiday). In order for
Beijing to boost the chances of reaching its 5% growth target, many suspect
more government support is needed. With the yuan recovering off its lower band,
and Chinese equities doing better, monetary policy may have more degrees of
freedom. The Third Plenary session has been set for July and additional
economic reforms may emerge.

Spot: CNY7.2410 (CNY7.2250) Median
Bloomberg One-month forecast: CNY7.2460 (CNY7.2065) One-month
forward: CNY7.0965 (CNY7.1180) One-month implied vol
4.6% (4.8%) 

Disclaimer 

Source: May 2024 Monthly